The Relationship Between IV in Volatility Products | Market Measures

While some market participants are likely slowly getting back in the swing of things, the tastytrade research team is charging hard into the new year.

The research guys recently introduced an interesting perspective with their Market Measures episode "IV of Volatility Products" - a no-nonsense examination of why relationships between implied volatility (IV) and an underlying are so different in volatility-based products as compared to traditional stocks.

As most tastytraders will likely already be well aware, a stock's price and associated implied volatility tend to move inversely.

The chart below illustrates this phenomenon very clearly in the S&P 500:

However, when looking at products that track volatility, the exact opposite relationship can be observed. In so-called "volatility products" (i.e. VXX), implied volatility generally moves in the same direction as the underlying.

The graphic below shows the correlated relationship between volatility products and their implied volatility:

In the case of stocks, it makes sense that a rise in the underlying would theoretically result in a reduction of IV (especially on average, over time). As stocks rise, especially if the pace is on the slow side, fear typically subsides and risk premiums decline.

On the other hand, a rise in VXX means that uncertainty is increasing, which in turn inflates the implied volatility of the volatility product's options.

This somewhat unorthodox relationship means that when traders deploy complex positions in volatility products they need to be cognizant of the risk exposure they are actually holding.

For example, getting long puts in a traditional stock would usually garner rich rewards when volatility increases (i.e. VIX goes up). Contrarily, in the VIX, a trader that buys puts is hoping for the opposite - a contraction in volatility.

The hosts of this particular episode of Market Measures, Tom Preston and Tony Battista, delve into much greater detail on the episode in regards to how traders can leverage this new understanding of volatility-based products and implied volatility in their own portfolios.

We invite you to watch the Market Measures episode for the full rundown of this topic when your schedule allows.

If you have any questions or feedback on today's post we encourage you to contact us at support@tastytrade.com

We look forward to hearing from you!

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.

Earning a certain average profit per month by selling premium is something of interest to many investors and traders. Until now, no one knew how much extrinsic premium needed to be sold to generate a targeted average monthly profit. We’re about to change that.

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer.

Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardize Options.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.